What, Me Worry?

By Andy Willms, President & CEO

In an attempt to vaccinate the U.S. economy from another Great Recession – or possibly even a Great Depression, the federal government has poured unprecedented amounts of money into the economy. While the injection of trillions of dollars of cash into the economy in the name of fiscal stimulus has been welcomed by many investors, business owners, and employees, doing so may have introduced a new risk: high inflation in the years to come.

Up till now, the financial markets have demonstrated little concern about the prospects for inflation in the near term. That’s understandable, given that efforts to contain Covid-19 have dramatically reduced consumer spending.

Now that the economy is opening up again, however, there are several reasons to be wary of the longer-term outlook for inflation.

(1) International trade, which has helped keep inflation in check, is under attack.

(2) The rise of populism, and the increased spending on social programs advocated by populists, creates inflationary pressures by increasing the money supply.

(3) The use of fiscal stimulus to provide a quick fix to economic woes has become increasingly endorsed by politicians of all types.

(4) As government debt grows, so does the attractiveness of using inflation to undermine the amount owed to reduce the real cost of servicing the growing liability.

Historically, rising inflation rates have led to lower stock prices in the short term. There are several reasons why. One is that rising inflation makes dividends to be received in the future less valuable. Another is that higher inflation is symptomatic of other economic conditions that are bad for stocks.

That said, over longer time frames the stock market has provided a decent hedge against moderate levels of inflation. That’s because, at least in part, a company’s revenues and profits should grow at the same rate as inflation, after a period of adjustment.

While inflation poses a serious threat to workers and business owners, its impact on investors is less clear. Investing in stocks can provide a degree of protection against inflation, provided your portfolio is well diversified and you are able to hold on to your investments over the longer term.

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